[Note: This post is about the original 2020 Congressional Directive that initiated the WIFIA Criteria. A recent post about a possible new Congressional Directive to revise the current Criteria is here: FCRA Plan C: Directive to Update the Criteria]

This is the first post in the FCRA Non-Federal Series.

It is not clear from publicly available information what caused the FCRA non-federal issue to surface at WIFIA.  It may have started with a 2019 Letter of Interest for a $569 million loan to a major stormwater diversion project in which the Army Corps of Engineers is a participant.  A half-billion-dollar loan is large relative to WIFIA’s typical loan amounts, and the Corps’ involvement was financially and operationally significant.  This may also have been the first time that WIFIA received an LOI from a project with any material federal involvement. But other dynamics may have been setting the stage prior to the appearance of a specific case.

Regardless of origin, once the issue was identified, it was apparently decided at a high level that a fast-tracked solution was required, perhaps in the expectation that more federally involved projects would soon be applying to WIFIA if the first one was successful.  The Congressional directive to develop a solution was in the form of nine provisos in the WIFIA section of the Further Consolidated Appropriations Act of 2020, a large bill passed in December 2019.  Here are the three important ones for this post:

That the Administrator, together with the Director of the Office of Management and Budget and the Secretary of the Treasury, shall jointly develop criteria for project eligibility for direct loans and loan guarantees authorized by the Water Infrastructure Finance and Innovation Act of 2014 that limit Federal participation in a project consistent with the requirements for the budgetary treatment provided for in section 504 of the Federal Credit Reform Act of 1990 and based on the recommendations contained in the 1967 Report of the President’s Commission on Budget Concepts; and the Administrator, the Director, and the Secretary, shall, not later than 120 days after the date of enactment of this Act, publish such criteria in the Federal Register.

That, in developing the criteria to be used, the Administrator, the Director, and the Secretary, shall consult with the Director of the Congressional Budget Office.

That the requirements of section 553 of title 5, United States Code, shall not apply to the development and publication of such criteria. 

The other six provisos described various aspect of implementation and the consequences of a failure to publish the criteria by the deadline.  The latter were far from hypothetical, as later events proved.

On the surface, the Congressional directive is straightforward.  It simply instructs relevant parties to get to work on a specific budgeting issue at a loan program and deliver a solution within a specified time.  The directive was ultimately fulfilled according to its terms, and the solution, WIFIA’s FCRA non-federal loan criteria, is now operational.  If a more complex story was involved (which I think is likely), it might not really matter at this point.  But a careful look at the directive’s language as passed will provide some insights into why the solution took its current form and how it might be improved.

Project Eligibility

In its first sentence, the directive describes the sought-for solution in terms of ‘project eligibility’ for a WIFIA loan.  That seems innocuous, since the path towards the goal of excluding improperly budgeted loans from WIFIA’s portfolio would seem to start at the project level, where federal involvement occurs.

However, with respect to the specific FCRA issue and how an instruction’s words might shape its outcome, I think a more precise description of ‘eligibility’ was called for here. This is because the WIFIA Program has several layers of eligibility for different purposes, every one of which must be passed before executing a loan commitment for a project:

• Threshold Eligibility:  These sections in the WIFIA statute describe what sectoral categories of projects, borrowers and activities are fundamentally eligible for a Program loan [1].  This type of eligibility reflects core policy objectives – every other type of ‘eligibility’ primarily involves specific risk and operational aspects of the Program that are necessary to achieve its objectives.

• Transaction Criteria:  A proposed transaction with threshold eligibility is then evaluated with criteria in roughly two areas of focus.  The first area is about the project asset itself – size, public sponsorship, and O&M.  The second is financial, ultimately with respect to the quality of the specific loan being sought – creditworthiness, source of repayment and SRF alternatives.

• Selection Criteria:  After a proposed transaction passes the asset and financial tests, it is ranked relative to the other transactions that the Program is considering with respect geographic diversification, readiness to proceed, regional need, etc.  This process implicitly assumes WIFIA won’t have the resources to execute loan commitments with all the eligible WIFIA applications completed in a funding cycle, and prioritization is necessary.  So far, this has been the case, but only by a small margin.  A few projects each year have been put on a waiting list, some of which have then been done when higher ranked projects were delayed or dropped out.  Importantly for the FCRA issue, “the amount of budget authority required to fund the Federal credit instrument” is explicitly stated in this section.

In this more nuanced context of WIFIA ‘project eligibility’, where would a solution for the FCRA budgetary issue fit best?  Presumably not as a modification of the threshold eligibility sections or asset-focused criteria since only the project’s loan is subject to FCRA treatment.  That leaves the financial criteria or the selection process as ways to make a non-FCRA loan ineligible.  Either would seem to work.  Like creditworthiness criteria, FCRA criteria in the financial section would include looking at the physical and contractual aspects of the underlying project that are relevant to the specific loan’s ability to meet a certain minimum standard.  FCRA criteria applied to loans in the selection process wouldn’t be so determinative because it is theoretically possible that WIFIA might have the budget resources to fund a non-FCRA loan.  But as a practical matter, that’s effectively impossible [2].  For a minimalist approach to the solution, the selection process also helpfully includes a criterion for ‘budget resources’ – if the FCRA issue is a budget problem, that is a precise location for a budget solution [3].

The Congressional directive’s language about project eligibility could have been interpreted in a way that reflected the specific eligibility most relevant to the needed improvement.  But the problem with the language is that it can also be interpreted in a broader way.  Without the necessary depth of context, the directive could even be understood to ask for criteria that will determine project threshold eligibility based on FCRA budgeting concepts – an obvious category mistake [4].  Developing criteria for project asset eligibility is also a possible interpretation of the directive’s language – less obvious, but still the same category mistake.

Does any of this matter? As things turned out, I think it did. The lack of precision in the Congressional directive would seem to be a factor in the fundamental shortcomings of the eventual outcome.

Some Other Items

Although FCRA-based criteria for project eligibility is the core of the directive, a few other items should be noted:

• The 1967 Report: Apart from FCRA law, Congress directs the relevant experts to consult the 1967 Report of the President’s Commission on Budget Concepts. This makes sense because the fundamental ideas behind what eventually became the current methodology of federal budgeting — and its FCRA subsection for federal credit programs — are outlined in this report. Since FCRA is silent about how to determine whether a loan is federal or non-federal, it’s necessary to go back to the law’s origins to develop guidance consistent with its intent. The 1967 report will be the subject of the next post in this series — and it’s actually an interesting topic. But I wonder if Congress intended to limit the basic sources for the criteria to this report and FCRA law? There have been a few precedents and analogous situations for the non-federal loan budgeting issue in the relatively recent past– can they also be considered? If not, why not?

• Treasury and CBO: WIFIA and OMB are obviously the most involved parties in the FCRA issue and the best-positioned to develop the needed criteria. Why was Treasury also included in a headline role? Was some type of financial expertise expected to be required? That seems like overkill for most WIFIA project loans, but to the extent it seems to acknowledge that the financial aspects of the project are at the core of a loan budgeting issue, that might make sense. CBO’s consultative role is also a bit mysterious, but that might be standard operating procedure for anything that affects the budget, or validity thereof. And CBO does of course score WIFIA legislation, including at a granular level with respect to the Program’s tax revenue impact (I’m not sure that the JCT always gets it right — but that’s another topic).

• Section 553 Exclusion: The reason for this is not clear to me. Again, it might be SOP for fast-tracked directives or (apparently) minor technical matters. The important aspect of the exclusion was that there was no mechanism or time period for public comment on the criteria, which were simply published and became operational in June 2020. In retrospect, excluding formal input on the issue from the potential WIFIA stakeholders outside the Program’s current borrower base was probably not an optimal approach. This will be a topic for future posts in this series.

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Notes

[1] Interestingly, WIFIA’s Section 3904 about eligible borrowers explicitly includes federal entities. In contrast, the equivalent section in TIFIA includes ‘any’ governmental entities. In the newer, post-criteria CIFIA and the Corp’s CWIF programs, it’s limited to state entities. Does this reflect some evolution in policy direction that was curtailed by the budgeting issue?

[2] The typical WIFIA loan is about $150 million, and this is probably much lower than the amounts sought by the type of large-scale water management project that has federal involvement. WIFIA’s annual credit subsidy appropriations have been in the $50-60 million range. If a loan can’t receive FCRA treatment, it’ll require budgetary resources of 100% of the loan amount in the year made. Even if the non-FCRA loan was the only eligible application that year, it would need to be rejected at the selection stage.

[3] In a strict sense, the mechanism to exclude non-FCRA loans already exists at WIFIA. The statute’s boilerplate definition of ‘subsidy’ refers to FCRA as the methodology that must be followed to calculate the required amount. FCRA law defines a ‘direct loan’ solely as a ‘disbursement of funds by the Government to a non-Federal borrower under a contract that requires the repayment of such funds’ — in effect, a non-federal loan. If a WIFIA loan can’t fit that definition, the implication is that FCRA can’t be applied, and the subsidy calculation must default to the general cash-based budget. It strikes me that WIFIA and OMB could have quietly developed appropriate non-FCRA loan criteria in this context and informed potential borrowers in the usual way — e.g., Program guides, a notice in connection with a NOFA, etc.

[4] Perhaps such a modification of Program policy could only be done by amending the statute?

WIFIA Program stakeholders will recall that the Program ran into a serious-sounding issue about correct budgeting a few years ago.  The issue arises when a WIFIA loan is made to an infrastructure project that has some degree of federal involvement.  Federal activities cannot receive the same FCRA budgetary treatment that WIFIA invariably uses for its loans.  How was the Program ensuring that loans for federal activities were excluded from its FCRA-based budget?  Since this question didn’t have a clear answer at the time, Congress in late 2019 instructed WIFIA, jointly with OMB and Treasury, to develop classification criteria to distinguish loans that could receive FCRA treatment and those that could not, due to federal involvement in the project being financed.  Non-FCRA WIFIA loans, regardless of being completely eligible in every other way, would become ineligible due to the application of the criteria.

Apparently, there was some delay in producing the classification criteria by the spring 2020 deadline.  Congress, through the appropriations process, took a surprisingly hard line on the matter and threatened to effectively defund the Program.  That got some press.  But the criteria were duly published shortly thereafter, threats withdrawn, and the expected WIFIA appropriations delivered.  By the end of 2020, the issue was apparently resolved.

Not There Yet

In fact, the outcome of this issue in 2020 was closer to truce than a permanent solution.  The correct budgetary treatment of WIFIA loans to projects with federal involvement is not a settled matter.  WIFIA’s current classification criteria can basically be ignored by state and local drinking and wastewater agencies.  This sector forms the vast majority of WIFIA’s applicants to date and is represented by the Program’s original advocacy groups.  It’s not surprising that they’d be willing to accept a quick (and to them, irrelevant) fix to keep the Program funded.  But that’s not the case for those water infrastructure sectors where federal involvement, due to history or scale, is a constant factor.  Projects in these sectors have to date not been frequent WIFIA applicants.  But they’re clearly eligible for loans in WIFIA’s statute and would significantly benefit from their features.  Yet the Program’s non-statutory budget classification criteria could effectively render many of them ineligible.

There’s no question that financings for federal activities belong in the main cash-based federal budget, not the specialized FCRA sub-section.  But precisely defining ‘federal activities’ in complex situations is not straightforward, a fact that has been recognized since current federal budget concepts were established in the 1960s.  Financing for large projects in which the federal government is just one of the participants is especially complex and FCRA law, although quite detailed in other ways, provides no guidance at all in this area.  Perhaps such guidance was not considered necessary when the law was passed in 1990 because federal loan programs for large-scale US infrastructure projects weren’t anticipated at the time.  But as WIFIA’s experience shows, current and future programs will attract a material number of important projects with federal involvement, an area that I think is likely to expand as the needs of US infrastructure renewal become more pressing.  Clarification of FCRA law’s current budget ambiguity associated with loans to federally involved projects is undoubtedly necessary and will ultimately benefit both federal taxpayers and infrastructure project stakeholders. 

But does WIFIA’s 2020 classification approach provide that clarification?  Or does it represent only a useful first step towards better solutions?  Is a process that involves a series of sixteen, primarily qualitative, questions going to produce clear results in an efficient manner?  Or would a statutory fix provide greater clarity and more equitable treatment for potential applicants?   Most importantly, are the concepts underlying the current classification approach the only possible interpretations of the intent of laws which determine federal budgeting methodologies but are silent on this issue?

Recent Developments

The above questions are not academic at any time, but three recent developments introduce an element of urgency in addressing them.  Unlike the single Congressional directive that framed the issue in 2020, these developments have multiple, disparate sources:

• GAO Report:  In July, the GAO published a long report on the issue, Transparency Needed for Evaluation of Potential Federal Involvement in Projects Seeking Loans.  The report primarily describes OMB’s thought processes and conclusions in developing WIFIA’s current criteria.  GAO did not question any of OMB’s interpretations or consider alternatives but recommends that “OMB should publish government-wide criteria…to help determine whether the project is eligible for the special budgetary treatment under FCRA.”  These would presumably be closely based on WIFIA’s current criteria and applicable to all current and future federal infrastructure loan programs.

• CWIFP Implementation:  In June, The Army Corps of Engineers published a proposed rule for implementing its WIFIA authorization, the Corps Water Infrastructure Finance Program, and applications are expected in the first quarter of 2023.  WIFIA’s current criteria are applicable to the CWIFP and may limit the scope of the Corp’s ability to utilize its authorization.

• HR 8127:  Also in June, HR 8127, The Water Infrastructure Finance and Innovation Act Amendments of 2022, was introduced in Congress.  Section 7 of this bill proposes a simple statutory fix to WIFIA’s FCRA issue based on the non-federal sources of loan repayment. 

FCRA Non-Federal Series

FCRA treatment for federal loans to federally involved projects is a big, multifaceted topic.  It needed to be examined in depth and in a methodical way to provide substantive criticism of WIFIA’s current classification approach and develop credible alternatives.  I tackled it in a series of posts, each based on one of the relevant documents, in a sequence that builds to overall conclusions at the end.  Posts in this series all include ‘FCRA Non-Federal’ in the title because that’s a succinct way to reflect the goal, which is to ensure that only non-federal loans receive FCRA treatment.  Here’s the sequence:

• The Congressional Directive
• 1967 Budget Commission Report
• 2017 CBO Report
• 2022 GAO Report
• The WIFIA Criteria
• HR 8127
• Tax Code Precedent
• Conclusion

In a prior, unexpectedly long, post, I explored the relationship between the intent of various laws underlying WIFIA’s budget and the ‘FCRA loss ratchet’ that made the Program’s actual, presumably unintentional results possible.  At the end of that post, I outlined some ideas to solve the issues going forward in a constructive way:

• The FCRA loss ratchet is probably an inevitable result (under current budget law and oversight methodology) of federal lending to highly rated borrowers with excellent financing alternatives who are building projects with long construction periods – two factors that practically define the state & local public agencies that do large-scale infrastructure projects in the US.  If federal infrastructure loan programs are going to have any significant impact on US public infrastructure, they’ll need to offer loans to this group.

• It’s not easy to develop loan features that are simultaneously attractive to these borrowers and fair to taxpayers when properly reflected in the budget.  The first thing to do, which is immediately applicable to WIFIA’s case, is to improve disclosure of a features’ real cost, especially with respect to future mandatory appropriations.  Disclosure will take the unintended fun out of offering ‘free’ products and encourage the development of less fun, but more impactful products.

• Innovation is the key to this kind of development.  An important principle should guide the process: Federal infrastructure loan features should always be based on deploying a federal lending strength, relative to private sector debt alternatives.  These strengths exist, even in times when the debt markets are operating normally.  If a loan feature deploys a federal strength, then a true increase in national economic welfare is possible along the lines of the benefits of ‘comparative advantage’ in trade theory.  If not, the feature probably involves some form of zero-sum transfer payments.  Transfer payments are the delight of rent-seekers and power-hungry bureaucrats, but in this context (loans to borrowers with excellent alternatives), the economic outcomes will be at best negligible, at worst significantly misallocating.

Innovation for federal infrastructure programs will be a central theme here.  This post will be limited to identifying two distinct paths to the goal.

I’ve written before about the potential for innovation at WIFIA and its implications for other programs.  Below is a presentation from about three years ago.  This was before I understood the scale of the FCRA loss ratchet issue, but I did highlight the fact that WIFIA was lending to highly rated borrowers, and many of the basic concepts are still relevant.

Wifia-Transformational-Development-Discussion-Outline-12302019

Two Paths: Project-Focused and Borrower-Focused

It’s useful to make a distinction between two areas of innovation that can improve federal loan products for large-scale public infrastructure because there are intrinsically two different elements involved – the physical projects themselves and the borrowers that make them happen.

Project-focused innovation should center on federal strengths that are relevant to specific infrastructure sectors or sub-sectors and don’t have efficiently accessed analogues in private-sector.  Some quick examples:

• Loan Term:  The most obvious and probably most substantive federal strength relative to any private-sector market is the ability to take a very long-term view of an investment.  It’s not universally relevant since many projects have useful lives well within standard tax-exempt bond market terms.  But where project life exceeds those, especially by a wide margin, loan programs should seek to maximize their ability to lend for the longest term possible.

• Specific Risks:  I don’t think the federal government has any unique comparative advantage in infrastructure risk assessment compared to private sector investors.  Probably the opposite, to be honest.  Certainly, a large government can simply absorb bad outcomes to a much greater extent, but then we’re back to transfer payments.  However, there are areas where the federal government already has an ineluctable risk position for basic policy reasons – disaster relief, for example.  To the extent that loan features can be designed to ‘hedge’ this risk by having contingent repayment terms that work in the opposite direction, real economic benefits could be realized.  I wrote about an example here: Contingent Loans for Climate Adaptation. Bit theoretical, no?  Well, innovation always starts like that – and there are probably more straightforward situations, especially at the infrastructure sub-sector or region-specific level.

• Interaction with Other Federal or State Policy:  When infrastructure projects need to conform with federal or state requirements anyway, that resets the ‘economic baseline’ on which the value of financing can be measured.  Who better to design federal loan features that exactly dovetail with such requirements than the government itself?  An example would be federal mandates for CSO improvements where WIFIA could specifically specialize in the financial aspects of compliance.  Not exactly a ‘federal strength’ in Pareto optimal terms perhaps (since the government created the economic friction that its loans seek to reduce), but close enough to our basic guiding principle here.

Project-focused innovation is very specific to different project types and sectors.  It can’t easily be centralized and ought to be kept at the individual agencies that host infrastructure loan programs.   

Borrower-focused innovation should center on federal strengths that are relevant to the financial goals and limitations of the type of borrower that typically implements US public infrastructure — highly rated public agencies. Quick examples:

• Interest Rate Management: The long construction periods of large-scale infrastructure projects require interest rate management products. Yes, I know — when they’re ‘free’, borrowers will snap them up, as they did at WIFIA. But I don’t think the development needs to be based on a budget loophole. Treasury has huge economies of scale, expertise and existing risk positions, all of which can be the basis of attractive loan features that are both based on federal strengths and properly budgeted for.

• Balance Sheet Management: Financing for large-scale infrastructure projects will put pressure on even the largest investment-grade balance sheet. I think the federal government has relative strengths in adding flexibility to large federal loans that wouldn’t be possible in the private-sector debt markets — single investor, buy-and-hold, deferral options, etc. A few are already deployed at WIFIA — more can be developed.

• Wholesale Lending to Retail Lending: There’s another type of highly rated infrastructure borrower that doesn’t in fact build projects itself — leveraged state-level infrastructure programs. Economies and efficiencies of scale are the fundamental strengths that federal loan programs could share with these lenders. I think there’s a lot of scope for purely financial innovation in this area.

Borrower-focused innovation can be centralized because the financial concepts and mechanics will generally be applicable across sectors. And because that type of innovation requires sophisticated financial and market expertise, it shouldn’t stay in silos at the host agency level, bureaucratic turf questions notwithstanding. The agency innovators should be busy enough with the project-focused features.

I think a natural center for borrower-focused innovation will be Treasury, since they’re funding the loans anyway. Here’s a diagram I had included in the 2019 presentation, updated to include CIFIA the new Corps’ program, CWIFP:

A prior post shows that a much smaller estimate of WIFIA’s likely interest rate re-estimate losses can be developed with a plausible-sounding methodology.  The realpolitik purpose is to provide the basis for a defensive narrative in case of ideological or political attack.

However, there might be another line of attack on WIFIA’s cost that doesn’t rely on the sticker shock of large numbers.  This one would be based on concepts that are close in spirit to the justifications put forward in 2020 by those in Congress who wanted to defund the WIFIA program about delayed criteria for lending to federally involved projects.  There was no discussion about the economic impact of the criteria (there isn’t any), the number of WIFIA loan applications that would be affected (very few – one or two annually) or the cause of the delay (almost certainly unintentional, perhaps pandemic-related).  Instead, the narrative centered on how WIFIA was violating sacred federal budgeting principles, opening the door to all sorts of abuse, disregarding Congressional intent, etc. etc.  None of it was particularly true or important, but that didn’t matter – the attack nearly succeeded.

A new version of the 2020 tactic would point out (with appropriate rhetoric) that WIFIA’s FYE 2022 portfolio will indisputably cost more than the discretionary appropriations allocated for it, and that oversight agencies should investigate the Program’s compliance with the Anti-deficiency Act.

The Anti-deficiency Act’s name is scary enough for plenty of soundbites, and the basic assertion is in fact correct, regardless of how the scale of the cost numbers might be packaged.  But on the surface, WIFIA’s defense is succinct and bulletproof:  FCRA law requires that the cost of interest rate estimates go into an off-budget account (for which permanent indefinite budget authority is provided) and the Anti-Deficiency Act explicitly excludes shortfalls of discretionary appropriations authorized by law.  Case closed, no?

It would seem so, and an attack along these lines is perhaps unlikely.  But I’m not entirely certain that the Program is permanently exempt from questions about the FYE 2022 portfolio’s obvious deficiency of discretionary appropriations.  There’s no doubt that the letter of the relevant law is being followed scrupulously, but is that true for its spirit or intent?  Did the lawmakers who wrote and passed the Anti-deficiency Act, FCRA and WIFIA’s statutes ever anticipate the possibility that a complex interaction of WIFIA loan terms, tax-exempt market rates and large public agency borrowers might check all their prudential boxes yet result in an unintended and massive cost to taxpayers?  Of course not.  And nothing prevents them from revisiting the law or its interpretations with better understanding of the implications of that interaction.

The FCRA Re-Estimate Loss Ratchet – A Predictable Outcome

I’ve often written about the tendency of FCRA re-estimates to be a “one-way ratchet of losses” when loan program borrowers have excellent financing alternatives.  If a borrower has a fixed-rate loan commitment from a loan program that can be drawn over a long construction period and cancelled without penalty at any time, they’ll only draw the loan when it’s cheaper than their current debt alternatives.  WIFIA borrowers are almost exclusively large, highly rated public agencies with excellent access to the tax-exempt bond market, where yields are close to, or even below, the Treasury curve on which WIFIA loans are priced.  Hence, WIFIA loans will only be drawn when their interest rates are below the Treasury rates that are used to calculate FCRA re-estimates, resulting in a loss.  Re-estimates gains at drawdown will be rare enough, but the loss ratchet doesn’t stop there — drawn loans that are more costly than the borrower’s then-current bond alternatives will likely be quickly refinanced.  The portfolio will relentlessly accumulate only those loans that result in a deficit between interest revenue and Treasury funding cost.  Regardless of other glittering metrics, it is a portfolio of interest rate losers.

And not small-time losers, either.  The deficit will be far larger than the Congressional appropriations authorized for the portfolio precisely because the borrowers have such high credit quality.  WIFIA’s discretionary appropriations are primarily allocated to a reserve for projected credit losses, which will be infrequent and minor for highly rated public agencies.  These losses are expected to be less than one percent of the loan amount, which in effect allows a leverage of discretionary appropriations (net of administrative costs) of about 100:1.  But funding losses arise from the entire loan amount.  In effect, the high leverage of the Program’s portfolio, combined with the loss ratchet described above, will result in funding losses that are orders of magnitude higher than discretionary appropriations. 

Obviously, this outcome was not the intent of the lawmakers who passed WIFIA’s statutes.  Did WIFIA’s program managers cynically plan to exploit a FCRA loophole and create a massive portfolio of loss-making loans to highly rated public agencies because loan volume itself is a measure of bureaucratic success?  Almost certainly not.  More likely, they just went with what apparently produced apparently great results in complete compliance with the law and didn’t seem to cost any budget resources.  But original intent, after five years of actual outcomes, is not especially relevant.  The FCRA loss ratchet is now a predictable outcome if WIFIA persists in lending to public-sector borrowers with excellent financing alternatives. The important question is whether anything can or should be done about it.

Re-examining the Law, and Application Thereof

Predictable losses from a federal loan program are naturally consistent with many policy objectives.  But such subsidies require discretionary appropriations – that’s the point of precisely calculating the future expected credit losses of WIFIA loans and allocating current appropriations as a reserve to cover them.  Credit losses are of course a well-understood aspect of making loans, especially for public-sector loan programs that are intended to support worthy but risky borrowers that might not have great access to private-sector alternatives.  Likewise, funding losses from loans are that explicitly priced at less than Treasury yields for policy objectives will require discretionary appropriations.  The FCRA loss ratchet, however, is a relatively complex financial concept that will apply in specific circumstances, and (so far) apparently in scale only at the WIFIA Program.  Apart from the specific losses at WIFIA, is it a problem worth focusing on with respect to fundamental, permanent solutions?

I think it is, for two reasons.  First, if there is a Solyndra-style ideological or political attack, bureaucratic fear will probably curtail interest rate management products at the Program and chill innovation in this area (or anything remotely related) at other programs.  That’s aside from the general discrediting effect on all future infrastructure loan programs.  But if WIFIA’s specific losses are characterized in terms of a larger problem encountered in a new (and very promising) area of federal infrastructure support, and fundamental fixes are being developed, a principle-based defense will deflect a (supposedly) principle-based attack.  The approach also goes beyond WIFIA.  Developing fundamental solutions to loan program budgeting ambiguities are both a useful short-term defensive tactic and a valuable long-term framework to keep the focus on loan program potential.

Second, even if there isn’t an attack, reliance on budgeting loopholes should be discouraged at WIFIA and other infrastructure loan programs.  Resource misallocation is ultimately not sustainable, regardless of the ability to hide federal losses, because it doesn’t produce real-world improvements.  Offering a free version of a loan feature that infrastructure agencies would ordinarily buy in the private sector might be a fun and easy way to build loan volume at a program, but it’s essentially a minor subsidy payment, unlikely to change much in terms of real-world infrastructure outcomes.  If the actual cost of that “free” feature had to be considered, other ways to deploy federal lending strengths would need to be explored by a program and its stakeholders, a path more likely to have a transformative effect.  Impactful policy development at loan programs requires budget discipline.  That discipline and its policy effects are improved if budget guidance is updated with depth and nuance when new situations arise.  

Fundamental solutions should start with the most fundamental law in this case, the Anti-deficiency Act.  Here is a core passage from a 2006 GAO report, Principles of Federal Appropriations Law:

The combined effect of the Anti-deficiency Act, in conjunction with the other funding statutes discussed throughout this publication, was summarized in a 1962 decision. The summary has been quoted in numerous later Anti-deficiency Act cases and bears repeating here:

“These statutes evidence a plain intent on the part of the Congress to prohibit executive officers, unless otherwise authorized by law, from making contracts involving the Government in obligations for expenditures or liabilities beyond those contemplated and authorized for the period of availability of and within the amount of the appropriation under which they are made….”

WIFIA loan commitments that, when drawn as loans, will predictably cause funding losses far in excess of the Program’s appropriations would clearly be prohibited if such losses were not in effect authorized by FCRA law.  I can see why there is an exception to Act’s overall “plain intent” for certain types of federal laws, those pertaining to core obligations like Social Security for example.  But does FCRA naturally belong in that category?  The lawmakers who wrote and passed the FCRA law obviously didn’t think that making loans was a core obligation of the federal government to its citizens.  In fact, FCRA is all about correctly assessing the amount of appropriations required to cover the cost of federal loans.  Yet there’s clear and succinct language in FCRA that provides ‘permanent indefinite budget authority’ (PIA) for interest rate re-estimates.  In effect, FCRA’s exclusion here creates the legal authorization for the Anti-deficiency Act’s exclusion — which in turn exempts WIFIA’s FCRA re-estimate loss ratchet from budget discipline and has allowed the Program to rack up billions in future mandatory appropriations.  How did PIA even get added to the FCRA law?  What was the intent?  How was it meant to be used?

FCRA law itself doesn’t give any indication on the intent of the PIA provision.  But that law is also silent on another budget topic that has arisen at WIFIA, the extent to which loans to federally involved projects can receive FCRA treatment.  To develop criteria for such loans, OMB was instructed by Congress to refer to a foundational document of current federal budgeting, the 1967 Report of the President’s Commission on Budget Concepts.  There’s an entire chapter on federal credit programs in that report which outlines the principles on which FCRA was ultimately closely based.  That seems like the right place to start.

The Commission makes it very clear that the full funding cost of federal loans needs to be calculated and paid for (emphasis added):

It is the Commission’s recommendation that the full amount of the interest subsidy on loans compared to Treasury borrowing costs be reflected and specifically disclosed in the expenditure account of the budget, and furthermore, that it be measured on a capitalized basis at the time the loans are made.

The phrase “at the time the loans are made” is more ambiguous.  Is the loan ‘made’ at the time of commitment?  Or when the loan commitment is drawn?  I think the Commission meant the latter.  Logic would suggest that “Treasury borrowing costs” are most relevant when the loan is being funded, not at the time of commitment, though the basis of future drawdowns (i.e., the loan’s fixed interest rate) is defined at that point.

Yet a loan commitment does create a federal obligation whose full cost requires the allocation of budgeted resources when the commitment is executed.  Since loans intrinsically include future variable factors, their cost is necessarily an estimate.  The Commission put some thought into that, most likely in connection with credit losses:

The Commission also recommends that effective measures be developed to reflect (in the expenditure rather than the loan account of the budget) the further subsidy involved in the fact that Federal loans have a larger element of risk than borrowing. This should be done by creation of allowances for losses and making appropriate credits to those allowances and charges to expense as new loans are extended.

Importantly, note that although the risk of future funding losses is not explicitly mentioned here, such losses are not conceptually different than future credit losses in the context of the Commission’s recommendation.  Federal loans that are drawn many years after commitment have repayment and funding risk.  The extent to which these risks will result in future losses is obviously not known at the time of commitment.  Hence, “effective measures” must be developed to reflect the expected cost as accurately as possible.  Such measures, customized for each borrower and individual loan, have been developed and are in full operation at WIFIA for individual loan credit losses.  “Allowances” for such losses are where the Program’s discretionary appropriations go.  Could equivalent measures be developed for estimating funding losses due to the length of time over which the WIFIA loan commitment can be drawn and considering the borrower’s financing alternatives?  The short answer is ‘yes’ even in the early-computer times of 1967 and certainly now.  Well, why didn’t it happen?

The clear intent of the relevant laws was to include the full cost of a loan in the discretionary budget.  Perhaps the lawmakers didn’t think that post-commitment funding losses would be material, and that the most efficient way to deal with such ‘noise’ was to dump it in an off-budget account with PIA, segregating it from the true budget ‘signal’.  That perspective makes sense given the typical characteristics of federal loans:  

• Federal loan program borrowers don’t usually have good private-sector debt alternatives, never mind excellent ones at near-Treasury rates.  Isn’t the lack of private-sector alternatives the point of loan programs in the first place?  Loan commitments to the typical federal borrower will be drawn (and sincerely appreciated) regardless of whether Treasury rates have risen of fallen.

• The time between loan commitment and drawdown is usually relatively short.  Infrastructure loan programs are rare and relatively recent in the total federal picture.  And even for these, construction loan commitments will be drawn as quickly as possible, regardless of alternative interest rates, because the project simply needs the money.  Likewise, construction loan commitments will only be cancelled if the project failed to proceed, an outcome not usually correlated with interest rates.

• With the two above factors, interest rate re-estimate gains will be about as frequent as losses.  On a portfolio basis, these would generally balance each other over interest rate cycles.  The re-estimate off-budget account might rise and fall at various points, but overall, it will tend to zero.  In that context, FCRA’s PIA for the re-estimate account is simply a smoothing mechanism.

As it turned out over the past five years, WIFIA Program’s typical loans have almost the opposite characteristics to those listed.  I don’t think anybody could have anticipated this outcome, least of all the lawmakers who created the Program. This is reflected in the short interest rate section of WIFIA’s statute, which clearly show the intention that WIFIA loans would at least cover Treasury’s cost of funding them, and discretionary appropriations were required solely for expected credit losses.  The lawmakers would have justifiably assumed that FCRA law, voluminous specific OMB methodology, and the overall intent of the Anti-deficiency Act and its legal framework would take care of the details.

Yet, like flowing water finding unexpected paths and causing hidden damage, WIFIA’s current FYE 2022 portfolio will ultimately cost federal taxpayers far more than Congress ever intended.  What can be done to mitigate the current damage and prevent more in future?

 A Simple, Wrong Answer

The simple answer is to limit (by law or policy) WIFIA’s ability to lend to borrowers that have efficient, near-Treasury alternatives.  The FCRA re-estimate mechanisms will then work as intended.  Future re-estimate gains will occur, and higher yielding drawn loans will stay in the portfolio.  That will stop further accumulation of losses and, over time, could offset some of the FYE 2022 portfolio’s future losses.

As noted above, that limitation is a naturally occurring element of basic policy rationale for federal lending in the first place – if borrowers have such alternatives, they don’t need federal loans, right?  It’s also indirectly indicated in OMB’s Circular A-129, which (among other guidance for federal credit) requires loan program reviews to address:

Why [program objectives] cannot be achieved without Federal credit assistance, including:

(I) A description of existing and potential private sources of credit by type of institution, and the availability, terms and conditions, and cost of credit to borrowers.

(II) An explanation as to whether and why these private sources of financing must be supplemented and/or subsidized.

The simple answer, however, is wrong, or at least an unnecessarily bad policy direction.  In the US, almost all basic public infrastructure is built and operated by state and local public-sector agencies which inevitably have high credit ratings and access to the tax-exempt bond market.  To take these borrowers out of the federal credit policy equation would practically guarantee that essential infrastructure loan programs will not have a significant impact in this critical economic sector.

A Better Approach

Instead of excluding important infrastructure borrowers, improve the programs.  For that objective, WIFIA’s specific issues provide a good framework to refine budgeting methodology and deepen policy rationale for highly rated federal borrowers – a lemonade from lemons approach.  The Program’s past and current travails with federally involved project criteria also provide some guidance as to how the re-estimate issue could play out, but this time towards a positive goal.  A Congressional directive to examine WIFIA’s future funding losses explicitly in the context of solutions that will allow the Program to keep lending to highly rated public agencies would be ideal.  For the immediate future, perhaps budget oversight agencies like OMB and CBO should be involved.  There’s a pre-emptive element to this, of course, but more optimistically they might be helpful in developing solutions that they know they’ll need to sign off on anyway for political reasons.

What might near-term solutions look like?  I can think of three directions that would seem to address WIFIA’s specific issues while laying the groundwork for more universal principles for improving federal infrastructure loan programs:

• Disclosure:  As always, more disclosure is a good place to start, especially with respect to program cost.  But it should not be limited to (or even focused on) FCRA estimates of economic cost, which are important but easily misunderstood in a political context.  Instead, other types of cash-based analyses in the most relevant budgeting period can be highlighted, and other factors (e.g., WIFIA loans’ effect on tax revenue) included.

• Treasury hedging:  If federal infrastructure loan programs are going to offer interest rate management products, Treasury should explore ways to actively manage their risk and cost to taxpayers.  In some ways, WIFIA’s current funding losses could have been substantially reduced if Treasury (working with input from the Program) had hedged loan commitment exposure.  WIFIA itself might not justify an extensive operation, but in the expectation of much-increased federal infrastructure lending, a pilot-scale initiative would be valuable for larger-scale development.  Active hedging at Treasury will likely incur a measurable budgetary cost, but that’s as it should be.  Since Treasury will have vast economies of scale and efficiencies relative to any private sector hedging alternatives, true economic gains are possible.

• Develop unique loan features:  This is the most important and substantive type of solution for both the budget and policy issues of federal lending to highly rated public agencies.  If programs can offer loans with valuable features that have no near-alternatives in the private-sector (a very long term relative to the municipal bond market, for example), borrowers will be reluctant to cancel commitments or refinance drawn debt of such loans simply because interest rates have fallen.  To the extent that such features are also based on relative federal lending strengths (there are a few, and they’re real) net economic gains are also possible.  In many ways, this ought to be overall goal of improving federal infrastructure loan programs.

I’ve written several long posts on this topic. You can read this short one instead.

It’s almost certain that WIFIA’s current $16 billion portfolio will require future mandatory appropriations far in excess of discretionary appropriations received by the program so far. There are various ways to look at the issue, as the chart above shows. This requires a narrative.

The shortest bar is the place to start. It reflects the portfolio’s projected cash requirements for the next ten years, (1) using CBO’s own economic assumptions and its standard budget time horizon, and (2) including increased federal tax revenue from WIFIA loans’ displacement of tax-exempt debt, per JCT methodology.

This approach results in about $700 million of mandatory appropriations over 2023-2032. That’s only $70 million a year, or less than one-half of one percent of the portfolio annually.

See? Not a problem.